Income Tax Folio S4-F15-C1, Manufacturing and Processing

Series 4: Businesses

Folio 15: Manufacturing and Research & Development

Chapter 1: Manufacturing and Processing

Summary

Section 125.1 provides for the taxation of corporations at a reduced rate on their Canadian manufacturing and processing profits. This takes the form of a deduction from Part I tax otherwise payable and is an amount equal to a specified percentage of a corporation's Canadian manufacturing and processing profits (subject to certain adjustments). This Chapter provides comments on various components of the calculation and discusses activities that are and are not considered to be manufacturing or processing.

Currently, the federal manufacturing and processing profits deduction rate is equal to the general rate reduction percentage as defined in subsection 123.4(1). This means that Canadian manufacturing and processing profits are currently taxed at the same rate as other active business income that is not eligible for the federal small business deduction. A number of provinces and Yukon provide special treatment for income that qualifies for the manufacturing and processing profits deduction (M&P credit). Therefore, the calculation remains relevant in those jurisdictions.

The Chapter also discusses the capital cost allowance (CCA) rules for certain manufacturing and processing machinery and equipment eligible to be included in Class 29, 43, or 53. These CCA classes provide accelerated write-offs for such machinery and equipment depending on when the machinery or equipment is acquired. For CCA information on buildings used for manufacturing or processing, refer to Class 1 on the CRA web page, Classes of depreciable property.

The Chapter includes a discussion of temporary enhanced CCA measures. These measures include the accelerated investment incentive (AII) and full expensing measures for M&P machinery and equipment included in Class 53 (or Class 43 for property acquired after 2025). These measures allow for a first-year enhanced CCA in respect of property that is accelerated investment incentive property (AIIP) as defined in subsection 1104(4) of the Income Tax Regulations. This measure includes a phase-out period starting in 2024 and will not be available for property that became available for use after 2027.

This Chapter also includes a discussion of the reduced corporate income tax rates for zero‑emission technology manufacturers and a temporary immediate expensing incentive in respect of designated immediate expensing property (DIEP) acquired by an eligible person or partnership (EPOP).

The final part of the Chapter discusses the federal investment tax credit that may apply to certain new buildings, machinery, and equipment (qualified property) acquired to carry out manufacturing or processing activities in certain regions of Canada.

The Canada Revenue Agency (CRA) issues income tax folios to provide a summary of technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, folios are used primarily by tax specialists and other individuals who have an interest in tax matters. While each paragraph in a chapter of a folio may relate to provisions of the law in force at the time it was written (see the Application section), the information provided is not a substitute for the law. The reader should, therefore, consider the Chapter’s information in light of the relevant provisions of the law in force for the particular tax year being considered.

The CRA may have published additional guidance and detailed filing instructions on matters discussed in this Chapter. See the CRA's Forms and publications web page for this information and other topics that may be of interest.

Discussion and interpretation

Manufacturing and processing profits deduction – M&P credit

Meaning of manufacturing or processing

1.1 The term manufacturing or processing is defined in subsection 125.1(3) to exclude certain activities. Specifically excluded are farming, fishing, logging, construction, certain resource activities set out in paragraphs (d) to (k), and activities where a 10% minimum threshold set out in paragraph (l) is not met. Because subsection 125.1(3) does not confirm which activities constitute manufacturing or processing, these terms are interpreted to have their ordinary meaning. As terms that do not lend themselves to any simple, all-inclusive definition, the meanings may evolve over time.

1.2 It may be said, however, that the manufacture of goods normally involves the creation of something (for example, making or assembling machines, clothing, soup) or the shaping, stamping, or forming of an object out of something (for example, making steel rails, wire nails, rubber balls, wood moulding). On the other hand, processing of goods usually refers to a technique of preparation, handling, or other activity designed to effect a physical or chemical change in an article or substance, other than natural growth. Examples of such activities are galvanizing iron, creosoting fence posts, dyeing cloth, dehydrating foods, and homogenizing and pasteurizing dairy products.

1.3 In Tenneco Canada Inc. v The Queen, [1991] 1 CTC 323, 91 DTC 5207, the Federal Court of Appeal indicated that the two tests for determining whether a taxpayer is engaged in processing are:

• whether there is a change in the form, appearance, or other characteristics of the goods subject to the operation; and
• whether the product becomes more marketable.

1.4 The activities of breaking bulk and repackaging for subsequent resale where there is a systematic procedure to make a product more marketable are generally considered to be processing. However, the filling of orders from bulk inventories is not viewed as processing where the activities involved are nothing more than counting or measuring and packaging.

General comments about the M&P credit

1.5 The M&P credit is applicable only to a corporation that carries on manufacturing or processing activities in Canada of goods for sale or lease. The manufacturer or processor of the goods need not necessarily be the vendor of the goods.

1.6 The M&P credit is not applicable to income arising from service or repair activities carried out on goods that are not for sale or lease. For example, altering or repairing articles of clothing that are already owned by the customer does not qualify as manufacturing or processing goods for sale or lease.

1.7 Similarly, based on the decision in Will-Kare Paving & Contracting Ltd. v The Queen, 2000 SCC 36, 2000 DTC 6467, the M&P credit is not applicable to income arising from the supply of goods through contracts for work and material. In this case, the Supreme Court of Canada concluded that the asphalt produced by a paving business was not considered to be a good manufactured or processed for sale or lease but instead supplied through contracts for work and materials. In other words, if goods that are manufactured or processed are used to carry out a service (for example, a repair service) under a single contract for work and materials, the goods are not considered manufactured or processed for sale.

1.8 A corporation that merely sells goods manufactured or processed by another party or supervises the manufacturing or processing of goods where the actual manufacturing or processing is carried on by another party will also not qualify for the M&P credit. However, based on the Federal Court of Appeal decision in McGraw-Hill Ryerson Ltd. v The Queen, [1982] CTC 167, 82 DTC 6142, where the goods are being manufactured or processed in Canada by another party on behalf of the corporation and the corporation exercises extensive involvement and control over the content, design, and physical qualities of the goods from inception to completion in Canada, the corporation may qualify for the M&P credit.

Activities excluded from the definition of manufacturing or processing

Farming and fishing

1.9 In general, a corporation with a farming business is not eligible for the M&P credit unless the comments in ¶1.11 apply. A corporation with a farming business may carry on certain activities that, if carried on by another person, would be considered to be the processing of farm products rather than farming. Some examples are: aging of cheese, plucking of chickens, cleaning, polishing, and treating of beans, and cleaning, sorting, grading, and spraying of eggs.

1.10 Similarly, a corporation with a fishing business is not eligible for the M&P credit unless the comments in ¶1.11 apply. A corporation with a fishing business may carry on certain activities that, if carried on by another person, would be considered to be the processing of fish products rather than fishing. The definition of fishing includes any activities incidental to fishing carried out on board the fishing vessel. Once the fish are caught and transported to a processing plant or cannery, any activities carried out to prepare the fish for market are considered to be processing activities (such as filleting, shelling, icing, canning, freezing, smoking, salting, cooking, and pickling). Where the processing activities are carried out on shore at a processing plant or cannery, a corporation with a fishing business will not ordinarily be engaged in processing activities.

1.11 Nevertheless, where substantial processing activities are carried out on board a vessel in Canada by a fishing corporation or where a farming corporation carries on substantial processing activities of farm products, the CRA will consider the processing activities to be a distinct business from that of fishing or farming where such activities are separated. However, there must be a clear delineation of the income from each business. Furthermore, the income from the processing business must be properly calculated without applying any of the special provisions in the Act dealing with income from a fishing or farming business, as the case may be. For example, the taxpayer could not use the cash method of computing income contained in section 28.

Logging

1.12 The CRA considers that logging does not include activities that take place after the delivery of the logs to a sawmill, pulp mill, plywood mill, or other similar place for processing logs. This means that the following are all activities that are considered to be manufacturing or processing:

• the operation of a sawmill to saw logs into lumber;
• the drying of lumber in kilns before shipment;
• the operation of a planing mill to plane lumber;
• the production of wood chips during the sawing process and the production of shavings during the planing process; and
• any similar activities.

The operation of bulldozers and boom boats at the mill site are considered part of manufacturing activities.

Petroleum and natural gas activities

1.13 Petroleum and natural gas activities that are not considered to be manufacturing or processing activities are:

• operating an oil or gas well or extracting petroleum or natural gas from a natural accumulation of petroleum or natural gas;
• processing natural gas as part of the business of selling or distributing gas in the course of operating a public utility;
• processing heavy crude oil recovered from a natural reservoir in Canada to a stage that is not beyond the crude oil stage or its equivalent; and
• Canadian field processing as defined in subsection 248(1).

1.14 The processing of natural gas at a straddle plant in Canada and the processing of natural gas in a plant in Canada that is devoted primarily to the recovery of ethane are both qualified processing activities.

Industrial minerals

1.15 Producing industrial minerals is considered to include all activities connected with the mining, excavating, and extracting of the material from the mine or pit area. This includes any primary crushing operation required to make it transportable from the mine or pit area as well as the transporting of the material from the mine or pit. Subsequent activities such as crushing, washing, screening, and sorting of the material in order to make the product of the mine or pit marketable are considered to be processing activities. The CRA recognizes that in some cases, some or all of these subsequent activities may be conducted within the confines of the mine or pit, in which case, processing will commence after the delivery of the excavated pit run material to the first of these processing operations.

1.16 The CRA considers an industrial mineral to mean a non-metallic mineral that is capable of being used in industry other than a mineral from a deposit that is a mineral resource as defined in subsection 248(1). Examples of industrial minerals include gravel, limestone, clay, sand, stone, and Feldspar.

Electrical energy and steam

1.17 The production or processing of electrical energy or steam used directly or indirectly by taxpayers in their own manufacturing or processing activities is generally considered to be eligible for the M&P credit. However, producing or processing electrical energy or steam for sale is specifically excluded from being manufacturing or processing by virtue of paragraph (h) of the definition in subsection 125.1(3). Such activities do not qualify for the M&P credit under subsection 125.1(1).

1.18 Nevertheless, a corporation that generates electrical energy for sale or produces steam for sale (including for uses other than the generation of electricity) may qualify for a separate M&P credit calculated under subsection 125.1(2) pursuant to a formula. Under subsection 125.1(5), for the purpose of certain parts of this formula, electrical energy and steam are deemed to be goods and the generation of electrical energy for sale and the production of steam for sale are deemed to be manufacturing or processing, subject to a 10% minimum threshold. However, the small manufacturers' rule described in ¶1.20 does not apply for the purpose of the calculation in subsection 125.1(2).

Calculation methods

1.19 There are two methods for calculating a corporation's Canadian manufacturing and processing profits. A simplified method is available to a small manufacturer provided that the corporation meets the qualifications in section 5201 of the Regulations. For other corporations, a basic labour and capital formula is used to determine their Canadian manufacturing and processing profits.

Small manufacturers’ rule

1.20 Section 5201 of the Regulations provides that a corporation will receive the reduced rate of tax on all of its adjusted business income if, in any particular tax year, it meets all of the following tests:

• its activities are primarily manufacturing or processing in Canada of goods for sale or lease;
• its active business income (net of any losses) and that of any associated corporations do not in the aggregate exceed $200,000;
• it is not engaged in any of the activities of farming, fishing, logging, construction, or specified resource activities;
• it is not engaged in the processing of the foreign tar sands and ore to any stage that is not beyond the crude oil stage, prime metal stage or its equivalent; and
• it is not engaged in a foreign active business.

1.21 The CRA's view is that the term primarily as used in paragraph 5201(a) of the Regulations signifies principally or chiefly and means more than 50%. A corporation’s activities are generally carried on by its employees. The CRA will look at the employees’ activities to determine if they are engaged principally or chiefly in manufacturing, processing, or something else. In some industries, the use of the company's assets in manufacturing or processing activities may also be considered where the use of labour does not accurately reflect the principal activities of the corporation.

Other corporations

1.22 Where a corporation does not qualify under the small manufacturers' rule, it must look at the definitions contained in section 5202 of the Regulations and determine the amounts needed for the formula contained in section 5200 of the Regulations. This formula provides that the corporation's Canadian manufacturing and processing profits are equal to its adjusted business income (refer to ¶1.23) multiplied by a fraction equal to the sum of the corporation's labour and capital costs used in manufacturing or processing activities over the sum of the corporation's total labour and total capital costs for all its activities. Many corporations may have difficulty in determining the amounts required by section 5202. Where a corporation can readily obtain information that is reasonably similar to that required by section 5202, it will be acceptable for purposes of the formula if no significant distortion of the formula results.

Zero‑emission technology manufacturing deduction

1.22.1 Section 125.2 provides a temporary reduction in the corporate income tax rate for  zero-emission technology manufacturers. This corporate tax rate reduction is provided in the form of a deduction from Part 1 tax otherwise payable by the corporation. This deduction is referred to as the zero‑emission technology manufacturing deduction (ZETM deduction). This corporate tax rate reduction is applicable for tax years that begin after 2021 and will be gradually phased-out for tax years that begin in 2029 and before 2032. See Table 1 below for the yearly corporate tax rate reduction and the gradual phase‑out. This is discussed further in ¶1.22.4.

1.22.2 Income eligible for the ZETM deduction is referred to as the ZETM profits of a corporation for a tax year. The term ZETM profits is defined in subsection 125.2(1) as the amount determined by the formula A × B × C where:

A = the corporation’s adjusted business income for the tax year.

B = the fraction that is determined by the formula D ÷ E, where:

D = the total of the corporation's ZETM cost of capital and ZETM cost of labour for the tax year, and

E = the total of the corporation's cost of capital and cost of labour for the tax year.

Element B calculates the proportion of the corporation’s total labour and capital costs for the tax year that are incurred in respect of qualified ZETM activities  which are described in ¶1.37.1 to 1.37.5.

C = one of two options, depending on the fraction determined for element B (i.e., D ÷ E):

• If this fraction is equal to 90% or more (90% test), then element C will be determined by the formula E ÷ D.
• If the 90% test is not met, then element C will be equal to one.

In general terms, the ZETM profits of the corporation are calculated by multiplying the corporation’s adjusted business income for the tax year by the proportion of the corporation’s total labour and capital costs for the tax year that is incurred in respect of qualified ZETM activities. By operation of the formula, if the 90% test is met, the proportion of the corporation’s total labour and capital costs for the tax year that are incurred in respect of qualified ZETM activities is deemed to be 100%.

1.22.3 Subsection 125.2(2) provides that the formula to determine the ZETM deduction is (A × B)+(C × D). The first part of the formula, (A × B), provides a rate reduction for ZETM profits that would otherwise be taxed at the general corporate tax rate. The second part of the formula, (C × D), provides a rate reduction for ZETM profits that would otherwise be taxed at the small business tax rate. The sum of these two parts will determine the amount of the ZETM deduction. The web page Corporation tax rates provides up to date information about specific tax rates. See Table 1 for the applicable tax rate reductions.

1.22.4 The tax rate reduction is highest in the 2022 to 2028 tax years, and is gradually phased out for tax years after 2028. Table 1 shows the yearly corporate reduced tax rates for both the general tax rate and the small business tax rate.

Adjusted business income

1.23 The term adjusted business income, as defined in section 5202 of the Regulations, is the excess of a corporation's income from active business carried on in Canada over its losses from similar businesses. The definition includes the corporation's share of active business income from a partnership but does not include income from an active business carried on outside Canada.

1.24 In addition, if a corporation has resource activities (as defined in subsection 5203(2) of the Regulations) for a tax year, subsection 5203(1) provides that its adjusted business income will be reduced by the amount, if any, of the total of:

• the amount by which its net resource income (as defined in subsection 5203(3)) for the year exceeds its net resource adjustment (as defined in subsection 5203(3.1)) for the year; and
• the amount of refund interest (as defined in subsection 5203(4)) included in both its income and adjusted business income (as defined in section 5202) for the year.

Cost of labour

Method of determining cost of labour

1.25 The most significant problem a corporation will face in calculating its Canadian manufacturing and processing profits is how to determine its cost of labour (as defined in section 5202 of the Regulations). The simplest method generally will be an analysis of the T4 slips. This will be particularly suitable for a corporation with a tax year ending on December 31. This will also be acceptable for many corporations whose tax years do not end on December 31, provided that the total of salaries and wages as shown by the T4 slips approximates the total salaries and wages for the fiscal year. For a corporation with a cost accounting system, an analysis of salaries and wages by each cost centre may be more practical. Where amounts are allowed as a deduction at year end as bonuses that are payable to specific employees, these amounts would form part of the cost of labour.

1.26 The figures most readily available for calculating cost of labour may include certain amounts (such as fringe benefits) that do not form part of salaries and wages on a strict interpretation of that term (as defined in section 5202). Where these amounts are insignificant in relation to the total salaries and wages of the corporation, their removal from the total is generally not required.

Interpretation of the word "normally"

1.27 In addition to salaries and wages paid or payable to a corporation's employees, amounts paid or payable to third parties for services that would normally be performed by the corporation's own employees form part of the cost of labour. The term normally means commonly, usually, or under normal or ordinary conditions. It would apply in cases where a corporation usually performs certain services or functions itself but for some reason, such as lack of capacity, short-run economic conditions, labour problems, or machinery breakdowns, has sublet all or part of the work to third parties. It is the CRA's view that what is normally performed is determined in the context of a service or function of a particular corporation and not in the context of the industry or a division of the corporation. Those corporations operating in more than one province will already have experience in calculating these amounts for purposes of allocating income to various provinces under subsection 402(7) of the Regulations.

Double counting problem – cost of labour

1.28 A problem will occur in a group of related or associated corporations where one corporation acts as a paymaster for the others. To mitigate the double counting effect that will occur when two related or associated corporations include the same salaries and wages in their cost of labour, the CRA will allow the corporation paying the salaries and wages to treat these amounts as net of amounts received or receivable from related or associated corporations in respect of these expenses, provided that this is done for both qualified activities and non-qualified activities carried on by the employees.

ZETM cost of labour

1.28.1 Effective January 1, 2022, section 5202 of the Regulations defines ZETM cost of labour for a tax year. It means the portion of a corporation’s cost of labour for the year that reflects the extent to which those costs were incurred in respect of:

• salaries and wages paid or payable to persons for the portion of their time that they were directly engaged in qualified ZETM activities of the corporation during the year; and
• other amounts paid or payable to non-employees for the performance of functions that would be directly related to qualified ZETM activities of the corporation during the year if those persons were employees of the corporation.

Cost of capital

Rental cost

1.29 The amount to be included as the rental cost of property (as defined in section 5202 of the Regulations) is the amount required to be paid under the lease or rental agreement regardless of whether the agreement is on a net or gross basis. Where the property rented includes land and buildings, an allocation of the rental should be made based on a split between land and building on some reasonable basis, and only the portion of the rental applicable to the building should be included in the rental cost.

1.30 Royalty payments are considered to qualify as rental costs under paragraph (b) of the definition of cost of capital in section 5202 of the Regulations. This will be the case provided they are payments made in respect of property that, if owned by the corporation at the end of a year, would have been included in paragraph (a) of the definition of cost of capital.

1.31 Since an accurate allocation of rental charges for the use of telecommunication equipment is impossible, the CRA will not require their inclusion in calculating cost of capital.

Double counting problem – cost of capital

1.32 A double counting problem occurs in a group of related or associated corporations where one corporation in the group charges another for the use of a building that it owns or rents. A rental charge appears in the cost of capital of both corporations and, in effect, is counted twice to the detriment of the group as a whole. To alleviate this inequity, the CRA will allow rents paid for a property to be netted with rents received or receivable from related or associated corporations for the use of that property. Similarly, if the corporation receiving such rents owns the building, it may exclude the portion of the capital cost of the building that related to the area rented to related or associated corporations from its cost of capital calculation.

ZETM cost of capital

1.32.1 Effective January 1, 2022, section 5202 of the Regulations defines ZETM cost of capital for a tax year. It means the portion of the cost of capital of a corporation for the year that reflects the extent to which each property included in the calculation of the cost of capital was used directly in qualified ZETM activities of the corporation during the year.

Qualified activities

1.33 The definition of qualified activities in section 5202 of the Regulations is relevant for purposes of determining what amount of a corporation's labour and capital is considered to be manufacturing and processing labour and capital. In addition to those activities that are manufacturing or processing within the ordinary meaning of the term, this section specifies several activities that are considered to be either qualified or non-qualified.

Receiving and storing of raw materials

1.34 Receiving and storing of raw materials are qualified activities. While activities related to the receiving and storing of raw materials away from a taxpayer's plant or warehouse are considered to be qualified activities, activities related to the transportation of the raw materials to the plant or warehouse are generally not considered to be qualified activities.

Line supervision versus administration

1.35 The terms line supervision (a qualified activity) and administration (a non-qualified activity) may be confusing. The CRA views administration as being the function of determining corporate policy and co-ordinating various activities (production, selling, etc.) of the corporation at the management level. Line supervision, on the other hand, refers to the line of authority for supervision of the manufacturing or processing activities of a corporation to the point where the activities of the supervisor can be said to be administrative. Since job titles and responsibilities vary considerably from industry to industry, identifying particular positions considered to be administrative is not possible. However, the persons who form part of the vertical line of supervision of the manufacturing or processing activities of a corporation, except those involved with the determination of corporate policy or the co-ordination of the production facilities, may be said to be involved in qualified activities. In most cases, the dividing line will occur at, or somewhere near, the plant manager.

Storing of finished goods

1.36 Storing, shipping, selling, and leasing of finished goods are non-qualified activities. If a good can be sold in bulk, but is packaged for the convenience of making the sale or because the taxpayer can receive a higher price if the product is placed in packages, it will generally be considered to be a finished good before packaging takes place. However, a homogenous product that must usually be broken from bulk and packaged before it can be sold is generally not considered to be a finished good until after it is packaged.

Data processing

1.37 One of the non-qualified activities is data processing. This term is intended to exclude accounting activities that are merely ancillary to a manufacturing operation. However, where a computer is used as an integral part of a qualified activity, that portion of the cost of the computer that reflects the extent to which the computer is used directly in qualified activities is included in the cost of manufacturing and processing capital. Similarly, the portion of time the computer staff spends directly engaged in qualified activities is included in the cost of manufacturing and processing labour. An example of a direct application of a computer to a manufacturing operation is where the computer controls and directs the manufacturing and processing equipment. The compilation of cost records, payrolls, etc., by a computer is not considered to be a qualified activity.

Qualified zero-emission technology manufacturing activities (qualified ZETM activities)

1.37.1 Effective January, 1, 2022 section 5202 of the Regulations provides the definition of qualified ZETM activities. A qualified ZETM activity, other than the conversion of a vehicle as described in 1.37.3, must first be a qualified activity for the purposes of determining eligibility for the M&P credit as discussed beginning in ¶1.33.

1.37.2 A qualified ZETM activity is an activity performed in connection with the manufacturing or processing of certain property described, in part, in clauses 5202(a)(i)(A) to (K) of the definition of a qualified ZETM activity as follows:

• certain solar, wind, or water energy conversion equipment;
• geothermal energy equipment;
• equipment for a ground source heat pump system;
• air‑source heat pump equipment designed for space or water heating;
• certain electrical energy storage equipment used for storage of renewable energy;
• certain equipment used to charge, or to dispense hydrogen to a zero-emission vehicle;
• equipment used for the production of hydrogen by electrolysis of water.

The manufacturing or processing of equipment that is a component of property included in the above list of activities may be a qualified ZETM activity if such equipment is purpose‑built or designed exclusively to form an integral part of that property.

1.37.3 A qualified ZETM activity is also an activity performed in connection with the manufacturing or processing of zero‑emission vehicles as defined in paragraphs (a) and (d) of the definition in subsection 248(1), or of automotive equipment (other than a motor vehicle) that is fully electric or powered by hydrogen. A zero-emission vehicle referred to above is a motor vehicle that is a plug-in hybrid with a battery capacity of at least 7 kWh or is fully electric, or powered by hydrogen. The manufacturing or processing of integral components of the powertrain of these vehicles or automotive equipment (including batteries, and fuel cells) may also qualify. The conversion, performed in Canada, of a vehicle (that is not a zero-emission vehicle) into a zero-emission vehicle can also qualify.

1.37.4 The manufacturing or processing of general purpose components or equipment that are suitable for integration into property other than property described in ¶1.37.2 and 1.37.3 do not qualify as a ZETM activity.

1.37.5 Paragraph (b) of the definition of a qualified ZETM activity in section 5202 of the Regulations provides that qualified activities that are performed in connection with production in Canada of certain gases and fuels may be qualified ZETM activities. This would include the production of hydrogen produced by electrolysis of water, and gaseous, liquid, and solid biofuels as defined in subsection 1104(13) of the Regulations. These biofuels are fuels that are produced all or substantially all from specified waste material under certain conditions.

Cost of manufacturing and processing labour and capital

Time spent in qualified activities

1.38 The cost of manufacturing and processing labour (as defined in section 5202 of the Regulations) includes salaries and wages paid to employees for the portion of their time that they were directly engaged in qualified activities. It also includes the portion of payments to third parties included in the cost of labour for services or functions directly related to qualified activities.

1.39 Many employees may spend relatively minor amounts of their time in activities other than their primary activity. To alleviate the task of making numerous allocations and calculations in determining the cost of manufacturing and processing labour, the CRA will generally accept the administrative practice of allocating all of an employee's time to their primary activity where it is reasonable to assume that more than 75% of that employee's time is spent in the primary activity. Of course, where this practice is followed, it must be applied consistently whether the employee’s primary activity is a qualifying activity or a non-qualifying activity. A 50/50 split of an employee's time is acceptable where it is reasonable to assume that between 50% and 75% of the employee’s time is spent in the primary activity.

1.40 Where a department or division only carries on qualified activities (engineering design, quality control, etc.), most of its employees will be considered to be directly engaged in qualified activities. However, clerical and administrative staff within that department or division are not considered to be directly engaged in qualified activities.

1.41 Where a bonus is payable to an employee who is directly engaged in both qualified activities and non-qualified activities such as administration, the portion of the bonus equal to the percentage of time that employee spent directly in qualified activities will be accepted by the CRA as part of the cost of manufacturing and processing labour.

Meaning of the expression "used directly"

1.42 The cost of manufacturing and processing capital (as defined in section 5202 of the Regulations) is that portion of the cost of capital that reflects the extent to which each asset is used directly in qualified activities. The term used directly refers to those assets that are an integral part of and essential to the particular qualified activities being carried on. In all cases, the nature of the activity with which an asset is connected, and not the nature of the asset, should be examined to determine its use. In the case of a building which houses both plant equipment and administrative offices, an apportionment of cost is necessary. Generally, office furniture and equipment is not considered to be used directly in qualified activities unless the particular item of equipment is used solely by a person primarily engaged in qualified activities.

Warehousing costs

1.43 A problem can arise in separating warehousing labour and capital costs that are qualified activities for the purpose of calculating manufacturing and processing labour and capital used in the formula in section 5200 of the Regulations. For example, the costs of storing goods purchased for processing would have to be separated from those that are not (such as the storing of goods purchased only for resale). Generally the separation of these costs is difficult and arbitrary because in many instances no separate identification of these categories of goods is possible. One method might be to analyze sales (by dollars or volume) of processed goods and non-processed goods. If the average time spent in storage by raw materials purchased for processing is greater or lesser than the average time spent in storage by materials purchased for resale, it may be necessary to weigh any calculations to produce a reasonable result. Since a 10% to 20% variance in the percentage of qualified warehousing labour and capital costs would not usually significantly affect the formula in section 5200 of the Regulations, it is not normally necessary that the taxpayer make elaborate calculations to separate qualified and non-qualified costs. However, any allocation should be reasonable and have some logical basis.

Capital cost allowance

Accelerated investment incentive – First-year enhanced CCA

1.43.1 The accelerated investment incentive (AII) provides a temporary first-year enhanced CCA for property that meets the definition of accelerated investment incentive property (AIIP) in subsection 1104(4) of the Regulations. This applies to property acquired after November 20, 2018 and made available for use before 2028. The general rules of the AII do not apply to M&P property that is AIIP and included in Class 53 (or Class 43 for property acquired after 2025). Rather, taxpayers can benefit from the full expensing measures for M&P property that is AIIP if acquired and made available for use prior to 2024. This measure includes a phase-out period starting in 2024 and will not be available for property that became available for use after 2027. During this phase-out period, a first-year enhanced CCA is available for eligible Class 53 property (or Class 43 if acquired after 2025) that is AIIP. Refer to Table 2 for Class 43 and Table 3 for Class 53.

1.43.2 The first-year enhanced CCA measures do not change the total CCA that is available over the life of the property. Rather, it suspends the half-year rule and increases the rate at which the capital cost of the property can be deducted. The enhanced CCA in respect of an eligible property can be claimed only in the first year that the property is available for use. After the first year, regular CCA calculations are applicable. For more information refer to the web page Accelerated Investment Incentive. For details describing when a property is put into use, refer to ¶1.32 to 1.37 of Income Tax Folio S3‑F4‑C1, General Discussion of Capital Cost Allowance.

1.43.3 To determine the enhanced CCA claim for eligible M&P property that is AIIP, the UCC of the class is bumped up before the CCA rate is applied to the net addition to the class. The bump up occurs by operation of elements A and B in the formula [A(B)-0.5(C)] described in subsection 1100(2) of the Regulations. This formula was introduced to subsection 1100(2) in order to provide for the enhanced CCA measures while maintaining the half-year rule for non eligible property. Element A provides the appropriate factor to determine the first‑year enhanced CCA, and element B computes the net addition to the class. The multiplication of element C by 0.5 provides for the half‑year rule. The cost of new additions to the class that do not qualify as AIIP would be included in element C and would be subject to the half-year rule.

1.43.4 The prescribed factors in paragraph (d) of element A in subsection 1100(2) of the Regulations are used to determine the appropriate factor in the bump up calculation for M&P property. Specifically, for property included in Class 53 (or Class 43 for property acquired after 2025), the appropriate factor to be used in paragraph (d) for element A is:

1.43.5 Subsection 1104(4) of the Regulations specifies the conditions that must be met for a property to qualify as AIIP. In general, the property must be acquired by the taxpayer after November 20, 2018, and become available for use before 2028, and meet the conditions in either subparagraph 1104(4)(b)(i) or subparagraph 1104(4)(b)(ii). Specifically:

• Subparagraph 1104(4)(b)(i) requires that no person or partnership has claimed CCA or a terminal loss on the property prior to its acquisition by the taxpayer.
• Subparagraph 1104(4)(b)(ii) requires that the property not have been acquired on a tax-deferred rollover basis, or previously owned or acquired by the taxpayer or a non-arm’s length person or partnership.

1.43.6 For purposes of subparagraph 1104(4)(b)(i), a property acquired from a non‑arm’s length party may qualify as AIIP if no CCA claims have been made in respect of the property. Under special rules in subsections 13(27) and 13(29), expenditures incurred over multiple tax years can be eligible for CCA claims before the property is completed or available for use. If the taxpayer uses these subsections to claim CCA, then this may preclude the property from qualifying as AIIP under subparagraph 1104(4)(b)(i) in the event of a subsequent transfer to a non‑arm’s length party. Subsection 1104(4.1) of the Regulations ensures that CCA claims made in respect of any portion of a single property are deemed to have been deducted in respect of a separate property. In this way, remaining expenditures for which CCA has not been claimed can satisfy the conditions of subparagraph 1104(4)(b)(i) and would be eligible for enhanced CCA.

1.43.7 If a property qualifies as AIIP solely by virtue of subparagraph 1104(4)(b)(i), then subsection 1100(2.02) of the Regulations may apply. This subsection can apply to restrict the enhanced CCA in respect of property acquired from a non‑arm’s length party for expenditures incurred prior to November 21, 2018 (and certain expenditures incurred after November 20, 2018). Such amounts would also be subject to the half-year rule. This provision ensures that non-arm’s length parties do not benefit from an enhanced CCA deduction on expenditures incurred prior to November 21, 2018.

1.43.8 The operation of the AII for manufacturing and processing equipment is described under the headings Class 43 and Class 53 and illustrated in Examples 3 and 4 respectively.

Immediate expensing incentive

1.43.9 Subsection 1100(0.1) of the Regulations provides a first‑year temporary CCA deduction on designated immediate expensing property (DIEP) of an eligible person or partnership (EPOP). This incentive is available only for the year in which the property becomes available for use and allows an EPOP to fully deduct the capital cost of eligible property in computing income for the tax year. The deductible amount is limited to $1.5 million per year, which must be shared among associated EPOPs and the limit is prorated for tax years that are shorter than 365 days. Subsection 1104(3.1) to 1104(3.6) of the Regulations provide various rules in computing the deduction. If the EPOP is a member of an associated group, the associated EPOPs must file an election in prescribed form with the Minister of National Revenue to apportion the $1.5 million immediate expensing limit. If this is not done, the immediate expensing limit is nil.

1.43.10 If the EPOP is a CCPC, the incentive is only available if the DIEP was acquired after April 18, 2021, and becomes available for use before January 1, 2024. For eligible individuals and certain Canadian partnerships, the property must be acquired after December 31, 2021 and become available for use before January 1, 2025. The availability of the enhanced CCA under the AII for M&P property would not reduce the maximum amount available under this measure. However, the total CCA that can be deducted over the life of the property cannot exceed the capital cost of the property. For more information, refer to the Department of Finance web page Expansion of the Eligibility for Tax Support for Business Investments.

Class 29

1.44 Generally speaking, Class 29 provides for a capital cost allowance rate of 50% on a straight line basis. The maximum capital cost allowance that may be claimed is 25% of the capital cost in the year of acquisition, 50% in the following year, and 25% in the third year (refer to paragraph 1100(1)(ta) of the Regulations). In addition to the maximum percentage of capital cost allowance allowed in the second and third year, the taxpayer may claim, for those years, any unused portion from the preceding years.

1.45 Manufacturing and processing property that was acquired during certain time periods was eligible to be included in Class 29. Pursuant to subparagraph (c)(iii) of Class 29, M&P machinery or equipment acquired after 2015 can no longer be included in this class. This means that taxpayers may now use Class 53 for M&P machinery or equipment acquired after 2015 and before 2026 that meet the requirements of Class 29.

1.46 To be eligible for inclusion in Class 29, the taxpayer must have acquired or manufactured property that was:

• used directly or indirectly by the taxpayer in Canada primarily in the manufacturing or processing of goods for sale or lease; or
• leased by the taxpayer (that is a corporation described in ¶1.47) to a lessee who was reasonably expected to use it, directly or indirectly, in Canada primarily in Canadian field processing carried on by the lessee or in the manufacturing or processing by the lessee of goods for sale or lease.

1.47 Property might have been manufactured or acquired by a corporation and then, in the ordinary course of carrying on business in Canada, leased to other taxpayers who were expected to use it, directly or indirectly, in Canada, primarily in Canadian field processing carried on by the lessee or in the manufacturing or processing by the lessee of goods for sale or lease. In order for the property to have met the requirements of Class 29, the corporation's principal business must have been:

• leasing property;
• manufacturing property that it sells or leases;
• lending money;
• purchasing conditional sale contracts, accounts receivable, bills of sale, chattel mortgages, bills of exchange or other obligations representing part or all of the sale price of merchandise or services;
• selling or servicing a type of property that it also leases; or
• any combination of these businesses.

1.48 The property must have been:

• property that would otherwise have been included in Class 8 (other than railway rolling stock or radio communication equipment);
• an oil or water storage tank;
• a powered industrial lift truck;
• electrical generating equipment described in Class 9;
• a portable tool described in paragraph (b) of Class 10, or general-purpose electronic data processing equipment and systems software described in paragraph (f) of Class 10; or
• general-purpose electronic data processing equipment and systems software described in paragraph (f) of Class 10, if the portion of that paragraph before subparagraph (i) read as follows:
  "(f) general-purpose electronic data processing equipment and systems software for that equipment, including ancillary data processing equipment, acquired after March 18, 2007 and before January 28, 2009, but not including property that is principally or is used principally as."

Class 43

1.49 Class 43 provides for a capital cost allowance rate of 30% applied to a declining balance subject to the application of the half-year rule. In general, Class 43 is for property acquired after February 25, 1992 that:

1. is not included in Class 29 or 53, but that would otherwise be included in Class 29 if that Class were read without reference to its subparagraphs (b)(iii) and (v) and paragraph (c); or
2. is property that is described in paragraph (k) of Class 10 and that would be included in that Class if read without reference to paragraph (b) of Class 43 and paragraph (b) of Class 41, and that, at the time of its acquisition, can reasonably be expected to be used entirely in Canada and primarily for the purpose of processing ore extracted from a mineral resource located in a country other than Canada.

Class 43 accelerated investment incentive property – first-year enhanced CCA

1.49.1 M&P property that is AIIP, which is acquired after 2025 and included in Class 43, is eligible for a first-year enhanced CCA rate of 55% as indicated in Table 2. The rates in this table are consistent with the rates during the phase out period for Class 53 property in Table 3. 

Class 53

1.50 Class 53 provides for a capital cost allowance rate of 50% applied on a declining balance subject to the application of the half-year rule. In general, Class 53 is for property acquired after 2015 and before 2026 that is not included in Class 29, but that would otherwise be included in that Class if:

1. subparagraph (a)(ii) of Class 29 were read without reference to "in Canadian field processing carried on by the lessee or"; and
2. Class 29 were read without reference to its subparagraphs (b)(iv) to (vi) and paragraph (c).

Class 53 full expensing measures

1.50.1 Class 53 property that qualifies as AIIP is eligible for full expensing if it is acquired after November 20, 2018, and becomes available for use before 2024. An enhanced first year allowance is available for Class 53 property that is AIIP and is acquired after 2023. This allowance will be phased-out as reflected in Table 2. The full expensing measures or the first year enhanced CCA effectively suspends the half-year rule for eligible Class 53 property. 

Note 3: As indicated in Table 2, for the years 2026 and 2027, the enhanced CCA rate of 55% also applies to Class 43.

Meaning of terms

Manufacturing or processing for CCA purposes

1.51 For the purposes of paragraph 1100(1)(a.1), subsection 1100(26), and Class 29, subsection 1104(9) of the Regulations defines manufacturing or processing to exclude certain activities. Specifically excluded are farming, fishing, logging, construction, and certain resource activities set out in paragraphs (d) to (k) of the definition. As subsection 1104(9) does not specifically indicate activities that would otherwise be "manufacturing" or "processing", these terms will have their ordinary meaning.

To be used directly or indirectly

1.52 The phrase used directly or indirectly was used in ¶1.46 in discussing a property’s eligibility for inclusion in Class 29. The phrase refers to property acquired by a taxpayer for the purpose of being an integral and essential part of the taxpayer's or lessee's manufacturing or processing activities. This includes any ancillary equipment such as furniture and fixtures, repair and maintenance equipment, and fire extinguishing equipment, which is acquired for use in those activities. Although such equipment is generally located in the manufacturing or processing plant, it may also qualify if located elsewhere. Furniture and equipment acquired by the taxpayer for use by the taxpayer or lessee primarily in activities such as selling, distribution, and administration, which are not manufacturing or processing, are not eligible for the accelerated write-off.

1.53 Direct or indirect use of a computer in manufacturing or processing is considered to include direct manufacturing and processing applications. It can also include ancillary activities such as maintaining inventory records, production scheduling, engineering design, and production control. It would not include the maintenance of financial and accounting information such as accounts receivable and payable records, general ledger accounts, payroll records, customer lists, and sales invoices and analyses.

1.54 When a taxpayer includes a property in Class 29, Class 43, or Class 53, the property will be accepted as having been manufactured or acquired by the taxpayer for the purpose outlined in ¶1.46 if it is actually used for that purpose and provided there has not been an unreasonable delay before the property is put into use. Also, it will generally be accepted that the property was manufactured or acquired for use as described in ¶1.46 if the property was not put to any use for an extended period of time after manufacture or acquisition and if there are sound business reasons as to why it is not being used as originally intended (for example, if it would be economically unsound to carry out the original intention because of unforeseen or changed circumstances).

1.55 In some cases, it may be difficult to determine the amount of time that a particular piece of equipment is used in the manufacturing or processing of those goods that are for sale or lease, and those that are not for sale or lease. In such circumstances, any reasonable method of determining the primary use of the equipment will be accepted. For example, when equipment is used in two operations, an analysis of gross revenue from each operation may be helpful in determining the primary use of that equipment.

Principal business

1.56 In determining the nature of a taxpayer's principal business as described in ¶1.47, the following factors will be considered:

• the number of employees engaged in each branch or phase of a company's operations;
• the amount of gross revenue from each phase of operations; and
• the amount of capital employed in each phase of operations.

1.57 Ordinarily, the above factors will be considered in relation only to a specific year. However, when a company's normal activities have ceased or substantially decreased, the pattern of operations over several years may be considered in determining whether there has been only a temporary break in the normal activities of the company or an actual change in the principal business.

Investment tax credit

1.58 Assets included in Class 29, Class 43, or Class 53 may qualify for an investment tax credit if the conditions contained in section 127 are met. One condition is that the property be qualified property. Qualified property is defined in subsection 127(9) with further elaboration provided in section 4600 of the Regulations. In general, qualified property includes certain new buildings, machinery, and equipment acquired to carry out specified activities in certain regions of Canada. Specified activities include, among others, the manufacturing or processing of goods for sale or lease. For new buildings, machinery, or equipment to be eligible for the 10% credit, such property must be used primarily in one of the following regions of Canada: Newfoundland, Prince Edward Island, Nova Scotia, New Brunswick, the Gaspé Peninsula, or certain prescribed offshore regions. For more information, see the Atlantic investment tax credit.

1.59 Qualified property must be property which was not used for any purpose whatever before it was acquired by the taxpayer. Where a taxpayer renovates a used property, the renovated property will be ineligible for an investment tax credit.

Manufacturing or processing for investment tax credit purposes

1.60 For purposes of the definition of qualified property, subsection 127(11) provides rules regarding the activities to be excluded from manufacturing or processing. In particular, paragraph 127(11)(a) indicates that:

• activities described in paragraphs (a) to (e) and (g) to (i) of the definition of manufacturing or processing in subsection 125.1(3) are excluded; and
• paragraphs (f), (j) and (k) of that definition are to be read in a certain manner.

Paragraph 127(11)(a) does not refer to paragraph (l) of the definition of manufacturing or processing in subsection 125.1(3). This means that paragraph (l), the minimum threshold test, is not taken into account in interpreting qualified property in subsection 127(9).

1.61 Paragraph 127(11)(b) provides that for greater certainty, manufacturing or processing goods for sale or lease for investment tax credit purposes does not include:

• storing (other than the storing of grain), shipping, selling and leasing of finished goods;
• purchasing of raw materials;
• administration, including clerical and personnel activities;
• purchase and resale operations;
• data processing; or
• providing facilities for employees, including cafeterias, clinics and recreational facilities.

Application

This updated Chapter, which may be referenced as S4-F15-C1, is effective January 30, 2024.

When it was first published on September 27, 2016, this Chapter replaced and cancelled Interpretation Bulletin IT-147R3, Capital Cost Allowance – Accelerated Write-off of Manufacturing and Processing Machinery and Equipment.

The history of updates to this Chapter as well as any technical updates from the cancelled interpretation bulletin can be viewed in the Chapter History page.

Except as otherwise noted, all statutory references herein are references to the provisions of the Income Tax Act, R.S.C., 1985, c.1 (5th Supp.), as amended and all references to a Regulation are to the Income Tax Regulations, C.R.C., c. 945, as amended.

Links to jurisprudence are provided through CanLII.

Income tax folios are available in electronic format only.

Reference

Section 28, 125.1, 125.2, subsection 123.4(1), 127(9), 127(11), the definitions of Canadian field processing and mineral resource in subsection 248(1), section 4600, 5200, 5201, 5202, 5203, 5204, subsection 402(7), 1100(0.1), 1100(2), 1100(2.02), 1100(26), 1104(3.1), 1104(4), 1104(4.1), 1104(9), paragraph 1100(1)(a.1), 1100(1)(ta), and Class 29, 43, and 53 of Schedule II of the Regulations.